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Brokers More Confident In Origin Energy

Australia | Nov 30 2017

This story features ORIGIN ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: ORG

Origin Energy has outlined substantial cost reductions for APLNG yet maintained FY18 production guidance.

-APLNG targets considered credible and increase confidence
-Lower debt and higher earnings needed to facilitate a reinstatement of dividends
-Committed to defend market share in retail

 

By Eva Brocklehurst

Origin Energy ((ORG)) is meeting expectations as it outlines credible targets for APLNG. The company announced the overhaul of its gas production business with a view to reducing costs. Of importance, is Origin's ability to convince the market that the target is reasonable and achievable.

Offloading the Lattice Energy business was the catalyst for taking a simpler approach and Citi notes large, centralised business functions have been removed in favour of an asset-specific approach. The broker was disappointed that the scope of cost reductions did not extend beyond APLNG but suspects the company would prefer to take investors on a cost cutting journey over the next few years rather than set a large target that is at risk of not being achieved.

This approach, Citi notes, ultimately proved successful for Santos ((STO)) and raised its credibility within the market. UBS, too, points out that Santos has already achieved similar cost reductions in nearby acreage, lending credibility to Origin Energy's ambitions. The broker is increasingly confident that lower debt and higher earnings will be forthcoming and facilitate the reinstatement of dividends in FY19.

The update also supports Ord Minnett's positive view that the focus is firmly on reducing debt. Guidance for net debt below $7bn by June 2018 was reiterated. The company intends to reinstate dividends only when it reaches its targeted capital structure, that equates to gearing of 25-30%. The broker notes options for growth in the longer term include Ironbark integrated gas, as well as renewable generation opportunities and fast-start gas plants and storage.

Deutsche Bank agrees the targets are achievable, given that the peer project, GLNG, has been able to achieve similar cost reductions. The broker factors in the full benefit of cost cutting from FY19.

Origin Energy has outlined a distribution break-even oil price of US$48/boe in FY18 from targeting a reduction of -$500m in capital and operating expenditure by FY20, bringing the break-even oil price down to US$40/boe. The cost reductions are to be achieved primarily by lower surface facility expenditure, or as UBS describes "no more gold plating", as well as a reduction in operating and finance costs.

Eraring

FY18 guidance now appears conservative, given higher output expected at Eraring – where an increase of 12-15% is guided – although the company would like to have the impact of summer in the bag before updating FY18. Improved access to export coal has been obtained because of an upgrade to coal offloading facilities, ensuring a lift in Eraring output.

UBS also believes the company is well-positioned in an increasingly volatile electricity market, as its internal generation creates a natural hedge. The company's energy markets should be able to achieve cumulative operating earnings (EBITDA) growth of 36% over the next three years. As the stock is trading at the lowest implied oil price under coverage, UBS maintains a Buy rating.

Despite higher Eraring output, Citi suspects the company has a preference to maintain a level of conservatism and reassess guidance after summer is over. On balance, the broker envisages upside risks relative to the generation portfolio performing less efficiently during high temperatures.

Deutsche Bank considers increased output from Eraring to be a short-term factor, which is likely to revert in FY19. In the retail market the broker observes the company is experiencing higher losses than it would like, particularly in Queensland, but is committed to defending market share. Origin Energy has also entered the Western Australian retail market and reported a strong start for the first four weeks.

Victorian retail price increases from January 1 are likely to be better than assumed in guidance, Credit Suisse suspects. After the major retailers brokered a deal with the Victorian government a 15% increase in Victorian retail prices is reportedly due January 1, above the level which management would have built into its FY18 guidance.

The broker also notes the company is dealing with cost pressures from higher activity in retail. An increase in churn and customer interactions have been observed and this necessitates an increase in expenses.

Well Outlook

Credit Suisse acknowledges the company has delivered on expectations set out in August for APLNG. Nevertheless, beyond this, the broker struggles to envisage how incremental unit cost savings could offset the 60% increase in the number of wells, if prior guidance for 500 wells per annum holds true.

A further reduction in costs per well is needed if prior forecasts for FY23 are to be achieved, in the broker's calculation, although actual evidence of rising costs would be needed for the market to start discounting this in the modelling. While FY18 earnings guidance is retained, Credit Suisse suspects that this will be bettered and increases its forecast to $1.79bn from $1.76bn.

Citi suggests averaging well costs is confusing and the implications over-analysed. The company has stated that cost guidance is not necessarily consistent with well activity. Origin Energy has guided to 250-300 wells next year but will drill more horizontal wells, which come at a higher cost. The company has stated that its capital expenditure is consistent with an initial 400 wells per annum guidance.

Citi is attracted to the earnings growth and free cash flow but the current share price signals the stock is fairly valued, based on long-term oil price forecasts of US$55/bbl, and the stock requires a more compelling entry point or oil prices of US$65/bbl to warrant a re-rating.

FNArena's database shows four Buy ratings and three Hold. The consensus target is $8.81, signalling -1.9%. Targets range from $7.35 (Deutsche Bank) to $9.90 (UBS).
 

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